Methods to Control Inflation
A moderate rate of inflation is sometimes considered to be essential but it varies from country to country and from time to time but as the rate of inflation crosses the desirable limit, certain measures are undertaken to prevent increasing undesirable inflation. Countries use monetary measures to keep the inflation under control.
The monetary policy is defined as the plan of action undertaken a monetary authority especially the central bank of a country. The purpose of monetary policy is to regulate as well as control the demand and supply of money to public. The goal of monetary policy is to set the inflation rate and interest rate at such a level that the currency of the country remains stable and trust in the currency is ensured.
Monetary Methods of controlling Inflation
- Bank Rate Policy: The bank rate policy also known as Central Bank Rediscount Rate is an important tool for controlling inflation. It is the rate at which the central bank buys or discounts the provided bills of exchange presented by commercial banks to build their reserves. The bank rate policy works as a monetary measure in two ways.
- Interest rate increase: In the time of inflation, the central bank of a country increases the rates of interest due to which the lending costs rises, as a resultant, commercial banks reduce their borrowing from central bank. With less rate of borrowing, the money flow from commercial banks to public reduces and this is how the central bank of a country controls the extent of inflation.
- Less Business Borrowings: When the central bank of a country raises the interest rate for commercial banks, the commercial banks then ahead raise the interest rate for individual and Corporation/Company borrowings which results in fewer borrowings from corporate sector. Increase in interest is usually a sign for corporate sector to pull up their socks because it would be difficult for them in the future. With this decrease in borrowings, inflation is also controlled.
- Cash Reserve Ratio: Also known as variable reserve ratio is a specific proportion of deposits that is mandatory for all commercial banks to maintain in form of cash reserves in central bank. The CRR (Cash Reserve Ratio) is determined and decided by central bank of a country to control the supply of money. With the increase in the CRR, the capacity of borrowing of commercial banks from central bank decreases and also does the power of public to lend money from commercial banks. With this the price of goods in the market can be controlled; to which extent they would increase or decrease. As a result inflation can be controlled.
- Government Bonds & Securities: The sale and purchase of bonds and securities of government by the central bank of a country characterizes the open market operation of an economy. When the central bank of a country buys government bonds and securities it further sells them to public with the help of commercial banks. When the commercial banks buy these bonds and securities, they transfer an adequate amount of credit to central bank, which results in decrease in rate of money production or credit production by commercial banks. This reduces the flow of money to public by commercial banks and due to this inflation can be controlled.
The fiscal measures to control inflation are comprised of government spending or expenditures, public borrowings and taxation. The people who study fiscal measures are known as fiscals and they assert that inflation is caused due to an excess of aggregate demand and aggregate supply.
An economy’s level of stability, employment rate of a country and an individual’s earning are deeply affected by the relationship of government’s spending and its tax rates implemented. A slight change in between these two can either cause inflation or deflation. These slight changes in tax rate and governments spending to control employment rate and demand for products are known as Fiscal policy.
Fiscal Methods of controlling Inflation
- By reducing publics volume of spending.
- By more internal borrowing by public authorities.
- By increasing taxes.
- By decreasing governments expenditure.
- By introducing more taxes and bringing more people in its coverage.
- By inducing wage earners to buy government bonds and securities.